I must confess to holding back from saying much about Trump’s infrastructure plan since it has only been sketched out at a high level. But even so, despite infrastructure being the new darling of economists as a high octane way to stimulate growth, there’s plenty not to like about the Trump version even at the 50,000 foot level:
“Public/private partnerships” mean using middlemen with very high profit requirements, making the process more costly than if handled by government entities directly. The Federal government has repeatedly executed large scale investment programs successfully of vastly more complexity than anything the private sector has undertaken (see Felix Rohaytn’s Bold Endeavors for examples; consider the space race for starters).
Private-sector deals will go whether the returns, which includes looting, is greatest, rather than where the need or long-term growth opportunities are best.
First, Trump implicitly promised to help revitalize parts of America that lost factory jobs, and many of those are in small to medium-sized towns. But for a project to be attractive to investors, it will need to serve large or at least large-ish numbers of users. That means even if downtrodden states do get some investment dough, it will almost certainly go to their cities, and not the boonies.
Second, the well-documented fact that investors demand excessively high returns make them prefer opportunities where cash flows are front-ended. That is not the profile of societally-desirable infrastructure project. As Andrew Haldane said in a 2011 speech, based on his work with Richard Davies:
Our evidence suggests short-termism is both statistically and economically significant in capital markets. It appears also to be rising. In the UK and US, cash-flows 5 years ahead are discounted at rates more appropriate 8 or more years hence; 10 year ahead cash-flows are valued as if 16 or more years ahead; and cash-flows more than 30 years ahead are scarcely valued at all…
This is a market failure. It would tend to result in investment being too low and in long-duration projects suffering disproportionately. This might include projects with high build or sunk costs, including infrastructure and high-tech investments. These projects are often felt to yield the highest long-term (private and social) returns and hence offer the biggest boost to future growth. That makes short-termism a public policy issue.
By relying on known-to-be-myopic private investors, Trump’s plan would double down on a known investor bias.
Infrastructure investment will provide an economic stimulus only to the degree it is truly incremental spending. If it merely moves government projects that would have been executed regardless into private hands and/or diverts private investor funding from private investments (not secondary investments, but the funding of corporate growth projects, such as financing smaller-tier private companies) it will not additive.
Some types of infrastructure deals are guaranteed bankruptcy futures. Toll roads, tunnels and bridges are sure losers. From a 2014 article in Thinking Highways:
Beginning with the contracting stage, the evidence suggests toll operating public private partnerships are transportation shell companies for international financiers and contractors who blueprint future bankruptcies. Because Uncle Sam generally guarantees the bonds – by far the largest chunk of “private” money – if and when the private toll road or tunnel partner goes bankrupt, taxpayers are forced to pay off the bonds while absorbing all loans the state and federal governments gave the private shell company and any accumulated depreciation. Yet the shell company’s parent firms get to keep years of actual toll income, on top of millions in design-build cost overruns….
Of course, no executive comes forward and says, “We’re planning to go bankrupt,” but an analysis of the data is shocking. There do not appear to be any American private toll firms still in operation under the same management 15 years after construction closed. The original toll firms seem consistently to have gone bankrupt or “zeroed their assets” and walked away, leaving taxpayers a highway now needing repair and having to pay off the bonds and absorb the loans and the depreciation.
The list of bankrupt firms is staggering, from Virginia’s Pocahontas Parkway to Presidio Parkway in San Francisco to Canada’s “Sea to Sky Highway” to Orange County’s Riverside Freeway to Detroit’s Windsor Tunnel to Brisbane, Australia’s Airport Link to South Carolina’s Connector 2000 to San Diego’s South Bay Expressway to Austin’s Cintra SH 130 to a couple dozen other toll facilities.
We cannot find any American private toll companies, furthermore, meeting their pre-construction traffic projections. Even those shell companies not in bankruptcy court usually produce half the income they projected to bondholders and federal and state officials prior to construction.
John Dizard in the Financial Times, points out a huge defect with the Trump plan: its dependence on equity tax credits. I must confess to not being familiar with this market at all, and merely having dimly wondered: “How will this work? Traditional infrastructure investors are pretty much the same as private equity investors: public and private pension funds, sovereign wealth funds, foundations, endowments, insurers. The overwhelming majority are tax exempt. So a plan that relies on tax goodies to make the returns work won’t appeal to the big money players who typically finance these projects.”
Dizard’s assessment is deadly. He points out that tax credit investors aren’t all that big a market, and banks are among the big players. He suggests that there is already a lot of product, meaning a that the effort to use this route to prime the infrastructure pump is likely to lead to even more of a buyers’ market, with the effect that infrastructure spending would take place on an even slower timetable than critics imagined. Yours truly, assuming the normal many moving parts in traditional “public-private” infrastructure projects, figured that there would be no meaningful new spending before 2018; Dizard suggests that even as of then, the additional investment would be modest.
Even worse for the long term, this market is teeny relative to the scale of the US economy. It may be because he could not get comprehensive data, but what appears to be the biggest segment of tax equity deals (and likely the overwhelming majority) is renewable energy projects, which totaled $13 billion last year. If any readers have figures on other segments, please pipe up in comments.
And the juicy part? Returns to tax-driven investors depend on having sufficient earnings to use the tax goodies. Trump’s plan to reform the tax code will make the value of those credits more uncertain and generally lower. And Dizard flags another issue: recessions mean these investments dry up entirely, which the reverse of what you want with a stimulus program. You want it to be most robust in bad times, and to tail off when the economy is strong.
Key sections from Dizard’s account, Tricky tax equity erodes US infrastructure boom:
Since the Republicans control the presidency and Congress, we can expect that, in one form or another, tax credits for infrastructure will play a larger role over the coming years. The incoming rulers are beginning to realise, though, that this will be a difficult path to faster growth.
We can see some of the problems by looking at the tax equity market. Tax equity deals vary considerably, but most of the time they involve the creation of a partnership between a developer and investors. It is a very odd sort of market, with slow-moving prices and extremely complicated, often idiosyncratic, documentation.
Tax equity is, in the end, a way to redistribute tax credits from cash-flow-poor developers to a small number of cash-flow-rich banks, institutional investors and corporations who have profits they need to shelter.
It works well when the state provides extra tax credits to induce investment in policy-favoured undertakings, such as renewables…..
In the early years of a project, the investor owns more equity and uses the value of the tax credits to offset their other income. In later years, the ownership ratio flips and the developer harvests more of the now less-sheltered income.
Not everyone can play this game. Both the buyside and the sellside in tax equity need sophisticated and reputable staff who know how to bargain over prices and, even more importantly, terms and conditions.
The developers need deal flow, which means they have to spend money on potential projects they might or might not be able to finance. The investors need to know which developers can be relied on to navigate projects through the engineering and regulatory challenges. Both sides need lawyers and consultants on tap who will come up with deal-specific analysis, rather than cut-and-paste boilerplate.
The investors tend to hold the advantage, since there is usually a larger weight of hopeful developers. Tax equity buyers get a return that discounts the value of tax credits, depreciation charges and taxable income. In recent months, wind energy projects with solid contracts and reliable developers might have earned them 7.5 to 8 per cent. Rooftop solar developers who bundle lots of small projects would be paying up to 11.5 per cent.
That is higher than the banks could expect from plain vanilla corporate lending, but cheaper than the developer would pay if he had to sell shares to a private equity investor…
This all sounds so virtuous and promising, with good returns and market growth, that you can see how it would appear to be a useful model for an infrastructure boom. However, there is a big difference between a cheerful PowerPoint version of the renewables tax equity market and the reality of turning it into a massive infrastructure programme.
To begin with, the “price” of tax equity is determined as much by tricky terms and conditions as it is by the returns I quoted. For example, if there is a chance that the target return for the tax equity investor could be reduced by any proposed changes in the tax laws, the developer has to make up the potential difference with cash payments to the investor.
Keith Martin, a project finance partner at Chadbourne & Parke, the law firm, in Washington, says more risk has been shifted to developers following the US election last November. For developers who are chronically short of cash, that is a problem.
Even in the relatively mature market for tax equity in renewables projects, these little tweaks can lead to substantial one-off costs that are hard to control. It is difficult to imagine how infrastructure tax credit enthusiasts will implement a programme 10 times as big (as some have proposed) over a much wider range of projects.
And tax equity tends to disappear when you need it most. In 2009, when the banks had no profits to offset with tax shelters, the tax equity market all but dried up.
So if, God forbid, there should be a recession in the next four years, would a conservative Republican House put massive payments to all sorts of developers into the federal budget? Or would the infrastructure plan go into a pro-cyclical tailspin?